Cooler market may suck air from bubble fears
Dear Steve:
I moved out of my home in Redondo Beach last summer and rented it out. Its value has gone up $130,000 in less than a year. But I'm concerned about the housing "Bubble Theory" and wonder if I should sell. Even if prices go down 20 percent, it will still have the value it had nine months ago. Has a "bubble" happened before, and what is the worst-case scenario in Redondo Beach or California?
-- Bubble-Boy Glen
Dear Bubble Boy:
The old carnival-game bark, "Round and round she goes -- where she stops, nobody knows," comes to mind when we ponder the still-healthy U.S. housing market.
For our own fun and games, let's toss around some of the prevailing economic philosophies and a few facts on this much-debated subject, and you can decide if a housing bubble really exists and if so, how close it is to bursting.
To some degree, the current bubble fears are a byproduct of the stock market's tech bubble that burst following the giddy dot-com days of the late 1990s. Unlike the stock market, real estate isn't subject to such dramatic volatility, historically. In fact, you'd have to go back to the Great Depression to find a wholesale housing bust in the U.S., say economists.
Further, there's no way -- barring a worldwide catastrophe -- that the housing market could lose 22 percent of its value in one day as the stock market did in October of 1987. A home is a good long-term investment, in part because there is little speculative trading and overbuilding, unlike the oversupply syndrome that dampened the commercial real estate markets in the early 1990s.
Some housing market "bubbles" have deflated in certain states in recent years as other markets in the same state soared. For example, when the tech bust hit, home values in San Francisco dropped suddenly, while the rest of California faired quite well on average. Of course, San Francisco quickly rebounded after people began to discover that they could finally afford to live there.
But there is some current evidence of unsettling trends:
- Studies show home prices rose at about the same rate as overall inflation from 1950 to 1995. But since then they've been tracking about 35 percent above inflation.
- Meanwhile, home prices have been rising faster than gains in family income by about 2 percent nationally.
- Also, rent prices rose 2 percent in 2003 while housing prices rose 8 percent. The gap is even bigger in Southern California.
I point that out because there is a theory circulating out there that says a home, like the stock market, has its own price-to-earnings ratio equivalency that really determines its value. Where the symptoms of rapidly rising average home prices come up against slowly falling market rents, the so-called "bubble" is pretty bloated, it says.
Those P/E equivalents were reached in, ahem, Southern California and a few other major U.S. markets in the mid-1980s, and mild-to-severe real estate "corrections" ensued.
I do think it's safe to say that the U.S. housing market is cooling. Last year's 7.5 percent gain in median prices for existing homes is expected to slow to 4.4 percent this year, according to The National Association of Realtors. Foreclosures are expected to be high this year, as well. And many prognosticators say interest rates will likely rise after the Presidential election, regardless of outcome, a development that could have a marked slowing effect on home sales and values.
Of course, some soothsayers say not to worry, because the national home market is still as much as 20 percent undervalued. And Fed chairman Alan Greenspan flat out denies there's a housing bubble.
For a more detailed examination of the bubble debate, read Holden Lewis' article in Bankrate, "Housing bubble may be illusion, but choices are real," as well as "Will rising rates deflate housing prices?" by Bankrate's financial analyst Greg McBride.
Then you can make your own bubble decision, Glen. Good luck with it.
